A publicly-traded corporation has 100,000 shares outstanding. Earni...

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A publicly-traded corporation has 100,000 shares outstanding. Earnings will be £500,000 at the end of year 1 and £800,000 at the end of year 2. An investment outlay of £200,000 at the end of year 1 has already been committed. The firm is 100% equity-financed with a required rate of return of 16%. It will be liquidated after 2 years. Assume that the firm operates in a world with perfect capital markets and pays out any surplus cash as dividends.

a. What is the current share price of a share of the firm’s stock?

b. An investor owns 10% of the outstanding stock and wants an income from the firm of £15,000 at the end of year 1. Show how the investor can achieve this (without assuming any change in the firm’s dividend policy). What percentage of the firm will the investor own after the end of year 1 if she follows this strategy?

c. How can the investor be given the same income as in part b by a change in the dividend policy of the firm? How many shares will the firm have outstanding at the end of year 1 under the new policy? What percentage of the firm will the investor own at that time?

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